Introduction

On 26 August 2016, the Market Misconduct Tribunal (the “Tribunal”) found Mr Andrew Left (“Mr Left”) of Citron Research, to have breached section 277 of Part XIII of the Securities and Futures Ordinance (the “SFO”) following proceedings brought by the Securities and Futures Commission (the “SFC”) by publishing a research report (the “Report”) on Evergrande Real Estate Group Limited (“Evergrande”) which contained false or misleading information and induced transactions in Evergrande.  This is the first time that the SFC has taken action against a short seller report.

Background

On 21 June 2012, Mr Left published the Report which contain false and misleading information about Evergrande and alleged, among other things, that Evergrande was insolvent and had consistently presented fraudulent information to the investing public. The share price of Evergrande fell sharply on the same day following the publication of the Research. The SFC also found that shortly before publishing the Research, Mr Left had a short position of 4.1 million shares of Evergrande which he subsequently closed, making a total profit of approximately HK$1.7 million.

Four Requisite Elements

Under section 277(1) of the SFO, four elements must be proved before the Tribunal can find that there is market misconduct. Those four elements are as follows:

• A person, whether in Hong Kong or elsewhere, must publish or disseminate information or be concerned in its dissemination. In the present case, was not in disputed that Mr Left headed the team that produced and published the Report or, at the very least, that he took a leading role in its production and publication.
• The information must be likely to induce another person to buy or sell securities in Hong Kong or must be likely to maintain, increase, reduce or stabilize the price of securities in Hong Kong. In respect of how “likely” is required, the Tribunal has found that is the information should have a real chance to induce another person to buy or sell securities in Hong Kong or to maintain, increase, reduce or stabilize the price of securities in Hong Kong and not a remote chance.
• The information must be false or misleading as to a material fact. The words “false” and “misleading” mean “untrue” and “to cause an incorrect impression”, respectively. A piece of information is “misleading” if it is inconsistent with the true state of affairs. The Tribunal explained that a “fact” may be said to be an item of verified information which is the independent reality of a matter as opposed to an opinion concerning it and the difference of the two elements is important to be recognised. A “material fact” is a fact that is sufficiently significant to influence a reasonable person to take a course of action, such as to deal in Evergrande shares in the present case.
• A person who has disseminated the information must know, or be reckless, or negligent, as to whether the information is false or misleading as to a material fact.

Knowledge

The Tribunal suggested the test as to knowledge could be formulated as: when Mr Left published the Report, did he know that the information was false and/or misleading? The Tribunal emphasised that it is not a dilution of the straightforward concept of knowledge. It merely takes into account those circumstances in which it is proved that a person knows the truth but by way of a façade seeks not to have confirmed what he already knows.

Recklessness

In respect of recklessness, it describes the state of mind of a person who pursues a course of action consciously disregarding the fact that it gives rise to a real and unjustified risk. The test is a subjective one, going to a person’s state of mind. In the present case, the test may be formulated in three questions: (a) Whether Mr Left was aware of the risk that the information was false and/or misleading when he published the Research? (b) Was Mr Left further aware that in the circumstances the risk was of such substance that it was unreasonable to ignore it? (c) Did he nevertheless, although aware of (a) and (b) above, continue to publish the Report? If the answer to each of the three questions is positive, he was reckless.

Negligence

In respect of negligence, it is not defined in the SFO. The Tribunal regarded that as the concepts of knowledge and recklessness are in their ordinary meaning, so must the concept of negligence. The concept of negligence is an objective one, being judged through the eyes of the “reasonable man”. Mr Left argued that negligence was not properly to be applied to all persons but only to those persons who, by their actions, had an existing duty and a standard of care to meet and it had to be demonstrated that the person stood in special relationship to the market, e.g. being a director of a listed company or a licensed person. Mr Left was neither the above nor in any way an “insider” in respect of Evergrande thus he owed no duty of care.

The Tribunal took the view that s.277(1) imposes liability on any person who disseminates false or misleading information that is likely to have an impact on the market, that is, to people at large or to any group of persons comprising members of the public. The provision did not support the argument of the necessity of an existing duty and standard of care. In the view of the Tribunal, the duty of care is a duty that is created by the statute itself and it is owed to the market. And if some existing “special relationship” must be proved in respect of each of the three alternative states of mind, it would follow that a person who had assumed no such “special relationship” would be at liberty to publish assertions as to material facts knowing that they would be likely to have an impact on the market and knowing that they were false or misleading: an open invitation to sabotage.

Conclusion

The Tribunal found Mr Left culpable of market misconduct within the meaning of s.277 the SFO by the following reasons: (a) Mr Left published the Research and thereby disseminated the information contained therein; (b) certain information contained thereon, e.g. that Evergrande had been culpable of “fraudulent accounting” and it was “insolvent”, was likely to impact on the Hong Kong market; (c) such information was false and/or misleading as to material facts or through the omission of material facts; (d) that Mr Left was reckless as point (c) above; and (e) that, if not reckless, Mr Left was negligent.

This case indicates that short seller reports may constitute market misconduct under the SFO if the report contains false or misleading facts which induce others to trade or not to trade in the relevant securities. A finding of market misconduct also makes the wrongdoer liable to pay compensation to those persons who suffer a loss as a result of the market misconduct pursuant to section 281 of SFO. Thus shareholders and management of listed companies who are subject of short seller reports may consider to utilise section 281 of the SFO to recover losses from the publisher of such reports.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.